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Working Papers

Abstract

The paper examines two interrelated questions: (a) the effect of capacity on wholesale pricing decisions in competitive settings, when both final demand and supply are price insensitive and (b) comparison of performance of two auctions (uniform and discriminatory) in such an environment. The problem is motivated by wholesale electricity market and the model allows us to explain high price volatility which is its common feature. The presented model focuses on the structural impacts of inelasticity and randomness of demand, variable production costs, and fixed capacity. We show that price dispersion stems from suppliers' randomized bidding and the variance of the price dispersion is mainly influenced by capacity utilization and "technological'' asymmetry among suppliers. Introduction of demand uncertainty increases the chance of price dispersion but not necessarily the magnitude of price variance. Empirical data from the New England Power Pool (NEPOOL) illustrates our theoretical predictions related to price dispersion. The comparison between discriminatory and uniform auctions indicates that, at symmetric equilibria, they yield the same average price but discriminatory auction results in lower price volatility and, thus, might be more desirable. This insight continues to hold with uncertain demand and well describes cases with asymmetric bidders.